Though navigating the current environment has undoubtedly been a challenge, the pandemic has provided an opportunity for certain differentiated retailers to further separate themselves from the pack, notes Doug Gerlach, editor of Investor Advisory Service.
Five Below (FIVE) is one retailer we believe will emerge from COVID-19 with its attractive growth prospects intact and potentially enhanced.
The company is the leading high-growth value retailer marketing merchandise generally priced $5 or less to teens and tweens, particularly Generation Z (ages 8 to 14) — and their parents.
The beauty of Five Below’s merchandise strategy is that teens and tweens have disposable income because their basic needs are met by their parents and goods $5 or less are easily affordable. To keep customers interested in visiting the stores, the company follows trends and fads by constantly turning over its product lines.
Five Below currently operates just over 900 stores across 36 states. Management believes it can grow its base to 2,500, and even this estimate appears conservative. We note that most existing stores are concentrated in the East, Southeast, and Midwest, with relatively fewer in the Western U.S.
COVID-19 dented the company’s fiscal Q1 results, with sales falling 45% and comparable sales down more than 50%. Trends have since improved, as nearly all Five Below’s stores have reopened and comparable sales were once again positive early in Q2.
In an economic downturn, the company should be relatively less affected given its value proposition, and the company’s experience during the financial crisis over a decade ago supports this. Furthermore, given the current stress on the retail sector and related permanent store closings, management believes there will be significant real estate opportunities.
The firm’s financial metrics and balance sheet remain strong. The company generally generates ample cash flow to fund new store expansion and entered the pandemic with a debt-free balance sheet. It ended Q1 with $139 million in cash and no debt.
We anticipate Five Below can grow its EPS 22% per year. A combination of high-teens unit growth, low-single digit comparable sales growth, and modest leverage lead us to believe this is possible.
Five years of annual earnings growth of 22% would imply EPS of $4.73 in 2024, and, when coupled with an average high P/E of 43.7, shares could reach $207.
For the low price estimate, we use the average low P/E of 24.7 and 2019 EPS of $3.12 to generate a low price of $77. The upside-to-downside ratio is 3 to 1 and compounded annual return potential is 14%.
